The latest herald from the Church of Morganomics

Économiste Monétaire

I know there are some Morgan Kelly fans here. Morgan's latest piece in the Irish Times:

Bank guarantee likely to deal a crippling blow to the economy wrote:

ANALYSIS: Government borrowing is not an immediate problem, but the extent of banks’ bad debts may prove catastrophic, writes MORGAN KELLY

BETWEEN COLLAPSING house prices, bankrupt banks and spiralling unemployment, you might be forgiven for thinking that fate has already dealt Ireland every misfortune in its hand. However, there may be one more unpleasant surprise in store for us, the prospect that international investors unexpectedly stop lending to the Government.

Economists call this a “sudden stop”. The original sudden stop occurred in 1998 when a default by Russia panicked lenders away from Latin America and plunged their economies into prolonged crisis.

The consensus among Irish economists is that government borrowing is not an immediate problem. Ireland has a low level of public debt by international standards, and even a few years of heavy borrowing will still leave it below Greek and Italian levels.

To understand why this view is too complacent, imagine that you are a bank manager and somebody that we will call Brian (not his real name) comes in looking for a loan.

Brian’s income is €30,000 and he would like to borrow €20,000 to cover living expenses. This sounds like a lot in these nervous times but, because Brian is not carrying much debt, you think you might lend to him.
However, Brian then lets it slip that, because his income is falling sharply, he will need to borrow at least as much each year for the foreseeable future. He also admits that, late one night and for what seemed like good reasons at the time, he somehow agreed to insure the gambling losses of some “banks”.

Brian has no idea how large these losses might be, but is starting to fear that they might be substantial. At this stage, you realise that Brian is on a trajectory into bankruptcy and show him the door.

Multiply the numbers in this story by a million and you begin to understand why Ireland makes bond markets nervous. First, the Irish economy is heading into a severe and prolonged slump that will force the Government to borrow heavily at a time when markets are increasingly reluctant to lend heavily.

Secondly, the Government’s delay in revealing how much its bank liability guarantee is likely to cost is making markets suspect that the final bill will be crushing.

After a decade of a credit-fuelled property bubble, the economy is not so much crumbling as vaporising: were we the size of Britain, January’s rise in unemployment would have been over half a million.

As the economy collapses, so does the Government’s tax revenue. This year the Government will have to borrow about €20 billion – everything it spends on wages or on social welfare – or about 15 per cent of a falling national income.

With no chance that the hopelessly uncompetitive economy will recover in the next five years and little sign that the Government has any appetite for serious cuts in spending or increases in taxation, borrowing looks set to continue at around this level for the foreseeable future.

If this borrowing was the limit of the Government’s liabilities, Ireland would probably just about weather the storm in the bond markets. Unfortunately, an elephant is lurking in the corner in the form of the bank liability guarantee, and this looks increasingly certain to sink the economy.

In my view, the Government has made insufficient effort to estimate how much its banks have lost. We have therefore had the bizarre experience of nationalising Anglo Irish Bank and recapitalising Allied Irish Banks and Bank of Ireland without knowing precisely the extent of their bad debts.

The Government has not updated its estimate of losses since Brian Lenihan’s boast that the liability guarantee was “the cheapest bailout in the world so far”, an assurance that already ranks in the annals of supreme political irony alongside Neville Chamberlain’s “peace in our time”.

The ability of the State to continue funding itself ultimately depends on the size of these bad debts. If they are of the order of €10–€20 billion, we will survive. If they are of the order of €50-€60 billion, we are sunk.

Irish banks could easily lose this much. If we suppose that most of the €20 billion lent to builders will not reappear this side of Judgment Day, along with 20 per cent of the €90 billion lent to developers, and 10 per cent of the €120 billion in mortgages, then we are already up to €50 billion.

These are only guesses. However, the continuing stream of revelations from Anglo Irish – which bear out the old investment dictum that there is never just one cockroach in a kitchen – suggest that they could be optimistic guesses.

To see what would happen to Ireland if foreign lenders suddenly pull the plug, we only need to look at what happened in Latvia last December. We would be forced to seek an international bailout, with the International Monetary Fund and European Union playing bad cop and good cop. We could expect cuts of one-quarter to one-third in public sector wages and social welfare benefits, and draconian tax rises to bring the deficit back to around 5 per cent of national income in two years.

There is actually a worse scenario where international bond markets suffer a general panic, like 1998. Not only does Ireland gets torpedoed, but also Portugal, Italy, Greece, Spain and Austria. The IMF and EU simply would not have the resources to bail out so many economies and we would be entirely on our own.

In circumstances where the Government could not even pay public sector salaries, the bank guarantee would immediately become worthless and we would see an uncontrollable run on all the Irish banks.

Watching the ineptitude and complacency of Lenihan’s bank bailout, we can understand increasingly how the people of New Orleans must have felt as they watched George Bush rescue their city: “Brianie: you’re doing a heck of a job.”

Particularly galling are the Government’s efforts to feign surprise and indignation at the behaviour of the banks, when the reality is that this is how we have always done business here. All that the Anglo affair has done is to hold up our grubby brand of crony capitalism for international ridicule.
For increasing numbers of ordinary people, the Irish economic miracle has turned out to be as worthwhile as a share in Bernard L Madoff Investments.

In return for working hard and paying their taxes, the lucky ones who keep their jobs can now look forward to pay cuts, negative equity and savage tax rises; while the unlucky ones face prolonged unemployment and losing their homes, their cars and everything for which they have worked.
If, on top of this, we suffer a sudden stop, people will see their pensions and Government spending slashed to pay off the gambling losses of Seán FitzPatrick and his pals. The Irish social fabric would certainly rip and unprecedented civil disorder ensue.

Bill Clinton’s feared enforcer James Carville once said that he would like to be reincarnated as the bond market, because that way you get to intimidate everyone.

Without decisive and intelligent Government action in the next few weeks, by the end of this year we will understand exactly what he meant.

Morgan Kelly is professor of economics at University College Dublin

Link.

snubbleste

Frightening

He's a good track record of getting predicitons right

silverharp

Économiste Monétaire wrote: »

Bill Clinton’s feared enforcer James Carville once said that he would like to be reincarnated as the bond market, because that way you get to intimidate everyone.

Thats the nub of it, I dont think the gov have factored in having to finance the public debt with high single digit or double digit rates, when incomes are dropping

ionix5891

interesting read, thank you

few questions for the experts here

assuming the scenarios outlined, of IMF coming in and cutting public spending, raising taxes etc, what will be the outcome for savers with money in irish banks such as BOI? will a run on the banks mean any money dissapear, the money that the ones among us who saved during the good times and didnt indulge in the mindless celtic tiger indulgences (stupidities?) :eek:

I am no expert, but I don't see money vanishing.

There is a state guarentee (which is partially causing this problem) on your deposit so I don't see money going.

ionix5891

i hope not (for own sake) as that would be a kick in teeth for people like me who saved, bad enough taxes will prob go up soon one way or another

from what i understand the current deflation is actually good for savers but bad for borrowers? if thats the case then whats so bad about deflation? if someone was reckless enough to borrow more than they can afford they should learn a lesson. or am i being to conservative/sensible here?

.

ionix5891

ionix5891 wrote: »

i hope not (for own sake) as that would be a kick in teeth for people like me who saved, bad enough taxes will prob go up soon one way or another

from what i understand the current deflation is actually good for savers but bad for borrowers? if thats the case then whats so bad about deflation? if someone was reckless enough to borrow more than they can afford they should learn a lesson. or am i being to conservative/sensible here?

.

Its the otherway around.

Deflation means that the euro I borrow now is worth more then the euro I pay back, so its bad for savers and good for borrowers.

The disparity isn't larger enough for me to go running to the bank to remove my savings though.

LightningBolt

Peoples ability to pay off debt during a deflation cycle reduces meaning that the debt takes longer to pay off and the debt increases as a percentage of a persons salary. Essentially salaries for the most part will decrease leaving individuals with less income to pay off their debts.

If there was a run on banks savers would be one of the last few people entitled to any funds that were left available. I imagine any commercial lending would be secured against the banks assets. So if there was a run on the banks there's a risk you would lose everything, the government guarantee would be incapable of covering the amount of potential liabilities that would be incurred by the banks.

ParkRunner

That is some piece by Morgan Kelly. So basically we are at the mercy of the true levels of debt in the banks and society in general? Anyone reading that would have very little confidence in investing in Ireland and those who are in the country would have very little confidence in investing in assets and going into debt if wages will slump. Vicious circle!

ardmacha

The government needs to get a grip! Reducing the deficit in the short term would increase confidence and reduce interest rates spreads, reducing the downside. Even the public sector pension thing and other cuts like the buses would be easier to get through if there was seen to be a plan involving everyone.

There are 3 sources of decline in the economy, the direct removal of the property bubble, the indirect effects of this in lower spending, including government spending and the effects of the international recession. More balanced countries are likely to improve in a year or two, cheaper oil, lower interest rates, stimulus packages and the like will have an effect. The Irish economy is not wholly uncompetitive, it has competitive sectors and those protected sectors that ran away with themselves. An open economy like Ireland will show some improvement when international trade generally picks up and if there isn't a global meltdown we can trade our way out if definite action is taken in the short term.

ionix5891

ouch thanks for the explanations

johnnyskeleton

ionix5891 wrote: »

assuming the scenarios outlined, of IMF coming in and cutting public spending, raising taxes etc, what will be the outcome for savers with money in irish banks such as BOI? will a run on the banks mean any money dissapear, the money that the ones among us who saved during the good times and didnt indulge in the mindless celtic tiger indulgences (stupidities?) :eek:

If you're worried about this, why not put your savings in several accounts, or better yet several non irish owned banks e.g. Northern Rock, Rabo, Postbank.

Deleted User wrote: »

Deflation means that the euro I borrow now is worth more then the euro I pay back, so its bad for savers and good for borrowers.

Let's say I have €1k saved and you have €1k borrowed. You make bananas and I eat bananas. 1 banana costs €1. Every year I eat 100 bananas and you make 100 bananas. In 10 years time I will have no more savings and you will have no debts.

Now, the cost of a banana deflates to €0.50. I still eat 100 bananas and you still make 100 bananas per year, but instead of taking 10 years, it will now take 20 years for you to pay off your debts. I couldn't be happier though, because my savings will keep me fed for twice as long.

Thus deflation is good for savers and bad for borrowers, all other things being equal.

flanzer

I hope so ardmacha....I really hope so

Économiste Monétaire

ionix5891 wrote: »

interesting read, thank you

few questions for the experts here

assuming the scenarios outlined, of IMF coming in and cutting public spending, raising taxes etc,

I think Morgan is purposely overstating the degree of archaic conditionality that the IMF imposes. We haven't seen that in the recent actions of the IMF crisis lending. I'm not saying that it couldn't happen, however, I disagree with scaremongering like that.

nesf

Deleted User wrote: »

Deflation means that the euro I borrow now is worth more then the euro I pay back, so its bad for savers and good for borrowers.

Other way around mate.

johnnyskeleton

johnnyskeleton wrote: »

Let's say I have €1k saved and you have €1k borrowed. You make bananas and I eat bananas. 1 banana costs €1. Every year I eat 100 bananas and you make 100 bananas. In 10 years time I will have no more savings and you will have no debts.

Now, the cost of a banana deflates to €0.50. I still eat 100 bananas and you still make 100 bananas per year, but instead of taking 10 years, it will now take 20 years for you to pay off your debts. I couldn't be happier though, because my savings will keep me fed for twice as long.

Thus deflation is good for savers and bad for borrowers, all other things being equal.

My bad, I was mixing up inflation and deflation in my head.

Inflation is bad for lenders, as what you get paid back is worth less then you lent out.

Deflation is bad for borrowers, as you are paying back (in real terms) more then you would if there were no deflation or inflation.

But in reality, you would want serious amounts of inflation or deflation before you start to get worried.

nesf

nesf wrote: »

Other way around mate.

Last time I thank one of your posts!!

nesf

Deleted User wrote: »

Last time I thank one of your posts!!

peasant

LightningBolt wrote: »

If there was a run on banks savers would be one of the last few people entitled to any funds that were left available. I imagine any commercial lending would be secured against the banks assets. So if there was a run on the banks there's a risk you would lose everything, the government guarantee would be incapable of covering the amount of potential liabilities that would be incurred by the banks.

hang on, hang on ...

So you're saying that this bank guarantee that is going to cost ordinary John Q Taxpayer an awful lot of money in higher taxes and worse services, the same bank guarantee that will probably cause the run on the banks in the long run will leave good old John Q with feck all if it comes to the crunch as some faceless orginsations run off with his hard earned ???

What kind of guarantee is this exactly?

nesf

peasant wrote: »

hang on, hang on ...

So you're saying that this bank guarantee that is going to cost ordinary John Q Taxpayer an awful lot of money in higher taxes and worse services, the same bank guarantee that will probably cause the run on the banks in the long run will leave good old John Q with feck all if it comes to the crunch as some faceless orginsations run off with his hard earned ???

What kind of guarantee is this exactly?

Essentially, if all the Irish banks collapsed (and that's a very big if), then depositors would rank lowish on the list of people to get paid (though above shareholders). If the bank fails then almost certainly there won't be enough to pay everyone off, so the Government would have to step in and give money to the depositors to cover what they lost. The thing is that between AIB and BoI (who'd have the majority of deposits) you're talking about 20 billion in reserves before they got the 7 billion from the taxpayer so it's not quite the doomsday scenario that it's painted to be sometimes.

The guarantee is simply a guarantee on all deposits in the Irish banks. Nothing else.

von Neumann

nesf wrote: »

The guarantee is simply a guarantee on all deposits in the Irish banks. Nothing else.

I believe it covers interbank lending as well :mad:.
We effectively extended our credit rating to all the Irish banks and there for left the international banks who lent to the Irish Banks off the hook.
They underestimated the risk involved with Irish Banks, but it was thier mistake not the Irish tax payers :mad:.

Unfortunately, if we piss off the international lenders they will take their ball and go home and probably sluk for a very long time. Leaving the Irish goverment high and dry.

I file all this under "Life is not fair and no body said it had to be!" :pac:

Time Magazine

Several posts have been deleted, please try and keep this on topic.

nesf

von Neumann wrote: »

I believe it covers interbank lending as well :mad:

Possibly, I think they come in under the umbrella of "depositors" but I could be wrong.

jmcwobbles

Oh my God that is the most terrifying article I've ever read - so basically we're all f*cked! :eek: :eek: :eek:

Économiste Monétaire

Just to clarify, the September '08 guarantee covers:

• all deposits (retail, commercial, institutional and interbank) and;
• covered bonds, senior debt and dated subordinated debt (lower tier II)

Link. Also, I don't know if anyone has checked the rate debt issuances of these institutions, but not everything is denominated in Euros.

lordhawhaw

Would the Gov ban the transfer of large deposits outside the country or prevent the golden boys from dissipating their dough to other jurisdictions? If the ship really was sinking I'm sure that would happen. Any comments? Is it happening at the moment?

nesf

lordhawhaw wrote: »

Would the Gov ban the transfer of large deposits outside the country or prevent the golden boys from dissipating their dough to other jurisdictions? If the ship really was sinking I'm sure that would happen. Any comments? Is it happening at the moment?

As far as I know, but I could be wrong, that kind of credit control (i.e. banning the moving of deposits abroad) would not be possible within the EU I imagine due to the whole common market thing. They might be able to stop transfers outside of the EU but I'm not well up on legislation on this area so I honestly don't know.

old boy

nesf wrote: »

As far as I know, but I could be wrong, that kind of credit control (i.e. banning the moving of deposits abroad) would not be possible within the EU I imagine due to the whole common market thing. They might be able to stop transfers outside of the EU but I'm not well up on legislation on this area so I honestly don't know.

i am old enough to remember being searched enroute to chelteham for excess cash of any kind

blast05

If you're worried about this, why not put your savings in several accounts, or better yet several non irish owned banks e.g. Northern Rock, Rabo, Postbank.

Is National Irish Bank the only non Irish owned bank operating in Ireland that is covered by a foreign governments guarantee ?? The Danish government in this case.

Gekko

I'm seriously wondering whether to pay the penalty for taking all of my money out of an 18 month BoI savings account I opened before all this started.

Then I'd need to decide where to put it...gold maybe.

Afaik Morgan has a European hideaway that he can take off to and escape this GOdforsaken country if he so wishes

andrewdeerpark

Go this on chain mail worth a read:

Heidi is the proprietor of a bar in Berlin. In order to increase sales, she decides to allow her loyal customers - most of whom are unemployed

alcoholics - to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).

Word gets around and as a result increasing numbers of customers flood Into Heidi's bar.

Taking advantage of her customers' freedom from immediate payment
constraints, Heidi increases her prices for wine and beer, the most-consumed beverages. Her sales volume increases massively.


A young and dynamic customer service consultant at the local bank recognizes these customer debts as valuable future assets and increases Heidi's borrowing limit.

He sees no reason for undue concern since he has the debts of the
alcoholics as collateral.

At the bank's corporate headquarters, expert bankers transform these
customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These
securities are then traded on markets worldwide. No one really understands what these abbreviations mean and how the securities are guaranteed.

Nevertheless, as their prices continuously climb, the securities become top-selling items.

One day, although the prices are still climbing, a risk manager (subsequently of course fired due his negativity) of the bank decides that slowly the time has come to demand payment of the debts incurred by the drinkers at Heidi's bar.

However they cannot pay back the debts.

Heidi cannot fulfill her loan obligations and claims bankruptcy.

DRINKBOND and ALKBOND drop in price by 95 %. PUKEBOND performs better
stabilizing in price after dropping by 80 %.

The suppliers of Heidi's bar, having granted her generous payment due
dates and having invested in the securities are faced with a new situation.

Her wine supplier claims bankruptcy, her beer supplier is taken over by a
competitor.

The bank is saved by the Government following dramatic round-the-clock
consultations by leaders from the governing political parties.

The funds required for this purpose are obtained by a tax levied on
the non-drinkers.

Finally an explanation I understand . . .